RepuSPX and its bigger-tent cousin, RepuStars Variety, were designed to capture latent reputation value not evidenced by stock price. According to Technology Option Capital, the portfolio manager, reputational value is created through the actions of all stakeholders. If this value is not recognized by investors, then the equity should yield above average returns upon its discovery.

Since 2002, weekly trailing 12-month returns of a simple reputation-based composite equity portfolio reconstituted algorithmically once a year from constituent members of the S&P500 composite equity index outperformed the S&P500 index 83.9% of the time. In 680 serial samples of trailing twelve month returns, RepuSPX generally outperformed SPX returning an excess of 8.9% on average (median 4.5%). In 92% of the cases of outperformance, the excess trailing 12-month returns were greater than 2%.

A time series plot shown below further demonstrates that there is useful information on latent (reputation-sourced) enterprise value in Steel City Re's Reputational Value Metrics. The cumulative price returns through 4 March 2016 are 324.5% for RepuSPX and 74.2% for the S&P500.

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Ken Goldman, CFO of Yahoo, was answering a question about the company's nagging human resource problem. ”When we came to the company, and we talked about acquisitions…frankly, companies did not want to be acquired by Yahoo…and for us to even acquire them we would have to pay a ‘Yahoo premium’ because they didn’t want to come here. That’s not the case any more.”

According to Yahoo's chief numbers guy, Marissa Mayer fixed Yahoo's #1 problem. Unfortunately, the actual numbers suggest otherwise. For while the annual report indicates Yahoo received in 2013 more than double the number of job applications it received in 2012, the applicants appear to be following the money. According to the career site Glassdoor, Yahoo was the third-highest-paying company in Silicon Valley for engineers last year, behind Juniper Networks and LinkedIn.

There's a reputation value link to this, and just like a recent note on Warren Buffett, it tracks back to costs. The thing about being a company with a great reputation is that this intangible asset usually provides savings on human resources costs. If a company has to pay an objectively measured premium to recruit employees, then the company's reputation (among labor) is not great.

CFO's should know better than to speak against their numbers. They're supposed to trust numbers - the same numbers trusted by the capital markets. Numbers are spin-free objective measures. It's the point Theodore Porter makes in his book, Trust in Numbers. Numbers are most trusted in environments where elites are weak, where private negotiation is suspect, and where trust is in short supply.

Let's look at some more Yahoo numbers. Yahoo is trading at 31 times earnings, just behind Google's 34x and way ahead of Microsofts' 14x. Those numbers are trustworthy, and they say investors have very high expectations -- arguably, frothy.

The expectations of other stakeholders are reflected in reputation metrics. Like other trusted numbers, they're based on objective quantitative criteria. The good news for Yahoo's stakeholders is that the 85th percentile ranking for the Reputation Premium among 137 peers indicates plenty of upside. It also may indicate that the reputation is not as strong as it could be for a company this prominent, and may explain the salary premium the company has to pay. (Paying top dollar and not making the 50 best places to work says all that another way). The 4.0% value for the Consensus Trend, CT, suggests that stakeholders are fairly confident that Yahoo's reputation is properly valued.

The upside, therefore, is less likely to be realized, and that will disappoint the equity investors.

For more background on the Consensiv reputation controls, click here. To view the December 2013 reputational value league table, based on Consensiv's metrics, and available exclusively at CFO.com, click here. Last, to read more about how reputational value is linked to stakeholder expectations and enterprise value, read, Reputation Stock Price and You: Why the market rewards some companies and punishes others (Apress, 2012) (click here).

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This Society, dedicated to the promulgation of the best practices for managing intangible assets, has for years argued that cash flows are materially impacted by how those intangible assets are appreciated and valued by stakeholders. The Society has also suggested that while intangibles may comprise 70% of the market value of the average public company, only around 14% of that market cap is vulnerable to swings in value based on the relative ability of the company to meet stakeholder expectations on the delivery of execution on the intangibles. The shorthand for all that has been the word "Reputation," which has helped link the accounting notions of intangibles to the overall operations of the greater business community in such areas as ethics, innovation, quality, safety, sustainability, and security.

A good friend of the Society, Ken Jarboe, President of Athena Alliance, has championed the cause of collateralizing intangibles. Giving visibility to intangibles, as would be the case in a loan, has been part of the Alliance's core mission. By implication, this is an approach to giving visibility to reputation, which in other studies has been shown to move the cost of debt up or down by around 60 basis points.

This week, Jarboe can claim partial vindication. He writes in the Intangible Economy blog of a new study by the UK government that provides specific recommendations for "Banking on IP."

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Just last week, Huygens happily shared news that management accountants were taking interest in reputation, a highly ethereal and ephemeral asset if there ever was one. Not that what was just shared is true -- reputation leaves a material mark on profit and loss statements which is why its management is so important, and so difficult.

Also, last Friday, the Society hosted its monthly Mission Intangible Monthly Briefing where the issues of giving substance to intangible assets was again hotly debated. Now Society friend Ken Jarboe, CEO of Athena Alliance, shares that intangibles are becoming less intangible as a result of new accounting rules.
The big news...is the treatment of spending on two intangibles: R&D and "creative works" -- which will be treated as an investment rather than an immediate expense ... This means that for purposes of calculating the size of the economy, this spending will be depreciated over a number of years just like spending on plant and equipment.

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The chairman’s letter in the annual report, signed 6 March 2012, is clear. “The board set three priorities for BP,” wrote Carl-Henric Svanberg. “Safety must be enhanced and embedded. Trust must be regained. Value must be created through a clear strategic plan”

Safety, now a factor in the executive bonus plan, is tangible evidence of the company’s strategic priorities of reinforcing safety and risk management, rebuilding trust and reinforcing value creation of its intangibles. At group level, the safety and risk management component includes targets for recordable injury frequency, loss of primary containment and implementation of change programmes. Rebuilding trust is focused on external reputation as measured by external surveys and internal morale as measured by surveys.

BP’s board considers reputation from two perspectives – the reputational risks to the group and the processes the company has in place to manage these risks. In 2011, the board reviewed external reputation data which looked at BP’s reputation in the UK and US. It also discussed the group’s communications strategy and its reputation management plan.

To assure that stakeholders know that BP is serious about reputation and its risk management, the annual report offers up the term 20 times in the 10k section 1A-Risks.
The term also appears liberally throughout the balance of the document for a total of 45 mentions over twenty different pages in the 300 page document.

In what appears to be a growing trend first announced formally at UBS, but clearly preceded by BP, both reputation measurement and reputational risk are major issues at the Board level. This is why: as reported here earlier, firms that have superior reputations newly discovered can pickup an average of 6% of market cap, while firms that experience a reputational crisis can lose an average of 7%. Anything that can precipitate a 13% swing in value is bound to get the attention of a corproate board.

The Steel City Re reputation metrics for BP this week show the following trends: BP’s reputational value metric, a non-financial indicator of reputational value, is stabilizing with a near median volatility relative to its peers, and a long term forecast of stability. The company’s corporate reputation ranking, an indicator of relative standing, places the firm in the 81st percentile. Since the volatility indicators are neutral, the data do not yet indicate a near term boost in equity returns above the median for the peer group.
After years of reputational volatility, it appears at this point that equity investors are waiting for further evidence of material risk reduction in RepRisk -- reputation risk.
Nevertheless, considering where things were two years ago, BP has come "a long way baby."

Mathew Philips, writing for Bloomberg Businessweek (March 7), is perplexed. After recounting recent history including the Securities and Exchange Commission's $550 million fine for misleading clients on securities that were "built to fail," the swaps engineered for the Greek treasury that went bad and exacerbated the nation's financial distress, and the apparent conflict of interest in the sale of El Paso to Kinder Morgan, he is faced with a troubling fact. "Goldman’s sullied reputation doesn’t appear to be negatively impacting its business. In fact, Goldman is outpacing its Wall Street competition recently in key areas of business. In 2011, Goldman was the top adviser for both global M&A and equity IPOs. A Bloomberg survey of traders, investors, and analysts last May showed that while 54 percent of respondents had an unfavorable opinion of Goldman, 78 percent believed that allegations it duped clients and misled Congress would have no material effect on its business."

Two quick charts on reputational value and reputational rankings based on Steel City Re data reinforce his observations: the reputational rank and reputational stability of Goldman Sachs are both in the top quartile of all 267 firms in the banking and financial services sector.

By five of the key "vital sign" reputational metrics shown at left, Goldman Sachs is looking good. Yet its return on equity -- reward to its long suffering investors -- is the the 17th percentile within this peer group. Contrast Goldman Sach's reputational standing with another full-service investment bank, UBS. UBS with a market cap of $50B compared to Goldman's $57B, has a corporate reputational ranking in the mid 40th percentile even though its return on equity is slightly less negative. Goldman's PE is excess of 26 while UBS's is around 11.

We call this reputational resilience, and having tracked and measured Goldman Sach's reputation for the past three years, we are not surprised. Notes Philips, "There’s a reason why firms keep doing business with Goldman, and it’s not because of its sterling ethical reputation."

Indeed, it is not. The six key business processes that underpin reputational value are ethics, innovation, quality, safety, sustainability, and security. In the investment banking sector, it is hard to argue that one firm is more or less ethical than the other. That makes other drivers of reputation more valuable, and the evidence suggests the most important of them is innovation.

Opines William Cohan who studied Goldman Sachs and their culture and was interviewed by Philips: “This gets back to the advantages that Goldman has had for years over its competition. They attract the best and brightest people. They consistently have the best risk-taking culture on Wall Street. No one understands the markets as well as Goldman.”

Bonds and equity are two very different animals. Bonds have few surprises. They have a defined coupon, a termination date, and if held to maturity, usually perform as expected. Equity has none of that, but everyone knows that equity comprises embedded options, intangible assets, that have value. Enter Ireland, which has married the surprise value of options -- real options at that -- with the bland expectations of bonds.

According to Bloomberg (Feb 28, Flynn), "under proposals to be laid out next month, the government will offer the visas to investors who spend at least 2 million euros ($2.7 million) on a new “low-interest” security, 1 million euros on property or invest in an Irish company. The sale is aimed at people from outside the European Union (EURR002W) who need permits to live and work in the 27-member bloc." That's right: Visa Bonds. Bloomberg adds that "The government hasn’t yet set the coupon, the rate of interest payable to bondholders. Buyers will be able to bring family members with them, the Justice Ministry said."

Huygens gives a tip of the hat to Ireland for innovative intangible asset monetization.

Social Capital: A New Strategic Play for Investors
Look for Companies with Heart and Soul

Barbara Gray, CFA,
Equity Analyst, Brady Capital Research

For those of you who participated in the Monthly Briefing last Friday “Sure, They Say They're Socially Responsible: ESG meets CSR”, with Rick Frazier (Founding Member and Research Director of Concinnity Advisors LP) and myself, you probably got the sense that neither Rick nor I are big fans of ESG or CSR. Although it is important for investors to incorporate ESG (Environmental, Social, Governance) factors into their analysis and valuation process, we believe that ESG is only one piece of a company’s risk/growth profile. And while it is encouraging that more and more companies are starting to undertake CSR (Corporate Social Responsibility) initiatives, we view this as more of a defensive politically correct move. We are more interested in how a company actually treats all of its stakeholders (customers, employees, suppliers, community, environment).

As I stated on the call, I believe social media is leading to the creation of a new form of equity called social capital with the following four investment characteristics:

• Liquidity - Facebook, Twitter, and LinkedIn are global, dynamic, 24/7 social exchanges that convert a company’s stakeholder relationships into highly intangible liquid assets and/or liabilities called social capital.
• Time Horizon - Social capital is a new form of equity that we expect to appreciate in value as Facebook, Twitter, and LinkedIn’s user bases continue to grow, new social exchanges such as Google+ emerge, the number of user connections within and between different social exchanges grows, and corporate penetration and usage increases.
• Unique Characteristics - Social media empowers the individual with a platform to influence, expose, and disseminate.
• Regulatory and Legal – Social media provides concerned citizens with a platform to self-organize, increasing their bargaining power to push for regulatory and legal changes and reform.

As evidenced by the fact that Time’s Person of the Year for 2011 was “The Protestor”, I believe social media is the catalyst that is ushering in the era of the Social Revolution. I expect the Social Revolution will lead to a rise in legal and regulatory reforms, which will in turn, erode the economic moats of companies whose competitive advantage is derived by exploiting constituents in their stakeholder base. This will increase the company’s risk profile, reduce its future growth opportunities, and result in the creation of negative social capital. A company’s negative social capital with its stakeholders is an intangible liability that, unlike goodwill, does not show up on a company’s balance sheet. However, from a discounted cash flow (DCF) valuation perspective, the simultaneous increase in a company’s assumed discount rate and decrease in its expected growth rate will lead to a negative multiplier effect and contraction in the company’s value.

On a more positive note, as I explored in the research report I published in November titled: “Social Capital: A New Strategic Play for Investors – Look for Companies with Heart and Soul”, I am excited about how the Social Revolution will foster in a new source of competitive advantage for companies with heart and soul that are focused on making a positive difference in the world. I believe the strong and authentic stakeholder foundation of a heart and soul company will convert into a high velocity of social capital as the company leverages the high level of enthusiasm and deep psychological attachment to the company’s brand and greater purpose.

If you are interested in finding out more about my Social Capital investment thesis, I would be happy to send you a copy of my in-depth research report. I recently launched Brady Capital Research as an investment research platform to pursue my Social Capital investment thesis with the vision to: “build a community connecting investors with heart and soul companies and leading-edge business strategists”. I would love to share and discuss my ideas with you from the Intangible Asset perspective. You can reach me at barbcfa@gmail.com.

Editor's Note:

Blog readers may purchase an audio file of the Mission:Intangible Monthly Briefing (MIMB) program, "Sure, They Say They're Socially Responsible: ESG meets CSR," from the IAFS store. Members of the Society receive fabulous discounts on these and other products. Click here for details.

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From the time of the pioneering work by Fombrun and others in the 1990's, market observers generally agreed that reputation was a source of equity value. When good, it drove customers to buy more at higher prices, employees to work harder for less, vendor and creditors to offer superior terms, equity investors to bid up multiples, and regulators to cast a more benign eye. Since then, punters have sought methods for linking to concepts into an equity strategy.

The dominant challenge has been the inherent nature of reputation. It is an epiphenomenon of the interplay between culture and operational matters on one hand, oversight and governance practices on the second, and allowing for a third hand -- how the package is presented and delivered to stakeholders. The latter is recognized as being generally in the domain of marketers, and since it represents the "last mile" to the stakeholder, it has received the lion's share of attention.

Reputation value can be teased out of equity value through major adverse reputational events. Many have been documented in this blog over the years. Informal estimates suggest that the cost of an adverse reputational event is around 5% of market cap. Steel City Re, the reputation risk insurance specialist, calculate a value closer to 7% but their model arguably ignores "lesser" reputational events. Since 2005 when the Economist Intelligence Unit published its seminal article on reputation risk, reputation management gained a new internal stakeholder - the enterprise risk manager.

These data affirmed management's need to avoid reputational risk, but they provided little in the way of guidance of how to avoid it. Also, while they suggested how much to invest in the avoidance effort, the lumpy nature of reputational events ensured that any classical actuarial model would leave a firm statistically comfortable with its risk management strategy and yet woefully underprepared.

In November 2011, Steel City Re announced that its data on reputational value indicators had been incorporated into an equity strategy and was available through Dow Jones Indexes. The ten-year history, several years of which have been published weekly on this site, indicated a significant outperformance relative to the benchmark S&P500 index. Critics suggested that the outperformance could be attributed to higher beta securities rather than an inherent value proposition associated with exploiting latent reputation value.

We now report an additional analysis of the RepuStars algorithm in which the stock selection was limited to the S&P500 constituent members only. Details on the 3-year old RepuStars Variety algorithm and the underpinning reputational statistics are provided elsewhere. In this study, stocks were selected by the algorithm at the beginning of each of ten years beginning December 2001. In general, the portfolios comprising stocks selected using the RepuStars Variety algorithm outperformed the universe of S&P500 firms (the Index) each of the ten years. The single exception was 2008 (image below). The ten year average was 6.5%, a value surprisingly similar to the 7% losses realized with adverse reputational events.

From an investment perspective, the portfolio based on the above would have produced an annual 9% cumulative return which is within 10% of the RepuStars Variety price index returns that are reported each Monday (image below).

The upshot is the reputation management is not only good risk management. It is a source of value creation. Firms that do it right can expect, on average, an additional 6.5% in equity value growth, and protection against 7% in equity value loss, all other things being equal. Arguably, there are very few managerial strategies a firm can pursue today short of inventing the next i-device or replacement for facebook that can deliver such value.

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In this month's issue of IAM magazine, #48, the regular contribution on reputation explains how this epiphenomenon can provide management with freedom to operate. In the words of editor Joff Wild, who also recently penned a much appreciated shout out, "Although it is intangible, reputation allows businesses and executives operational freedoms that lead to very tangible results."

Now for an update from the National Association of Corporate Directors. According to their daily newsletter, NACD Directors Daily (13 July), "In an rare example of how 'say-on-pay' votes can influence companies' relationships with some shareholders," Cincinnati.com (July 12, Boyer) reports that "a lawsuit has accused Cincinnati Bell Inc.'s outside directors of breaching their duty to investors and the company's top executives of 'unjust enrichment' over pay raises granted last year." The raises range from 54 percent to 80 percent for three of the company's top officers despite a 68 percent drop in 2010 net earnings. A non-birding shareholder vote in May opposed the pay raises. "The lawsuit was brought in U.S. District Court in Cincinnati last week by attorneys for the Illinois-based NECA-IBEW Pension Fund, a Bell shareholder," the website reports. "It seeks a court order and unspecified damages on behalf of the corporation, possible return or impoundment of the pay increases, and implementation of internal controls preventing excessive compensation to the company's top executives."

We've discussed "sue-on-pay" before. And we will again. It appears compensation is evolving into a contact sport.

NB: Further to recent queries from attentive followers of this blog, Huygen's will opine on the reputational crisis gripping News Corporation (NASDAQ:NWSA) presently.